2008 Trends: Subprime And Auction-Rate Cases Continue To Drive Filings, And Large Settlements Keep Averages High

Article by Stephanie Plancich, Ph.D. and Svetlana Starykh

with former NERA Consultant Brian Saxton1

Originally published July 2008

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2008 Trends: Subprime And Auction-Rate Cases Continue To Drive

Filings, And Large Settlements Keep Averages High in its

entirety, inclusive of all charts, footnotes and glossary of

terms.

If activity continues at this pace, there will be

almost 280 filings in 2008, the highest level since

2002.

Introduction

After a decrease in 2006, filings began to increase in 2007.

This trend has continued into 2008: currently, filings are on

pace to reach almost 280 for the year, a level not attained

since 2002.

What's driven the increase in filings? Clearly, the

current subprime and credit crisis is a major factor in the

recent surge in shareholder class action filings. In 2008, 51%

of filings through June 30 have allegations related to the

subprime collapse.

To test another potential driver of filings, NERA analyzed

the impact of market volatility on longer-term patterns of

class action filings. We find that high market volatility is

positively correlated with the number of filings: if market

volatility is higher during a quarter, controlling for market

returns, filings are likely to be higher in that same

quarter.

We have also examined the likelihood of a company facing a

class action filing following a large drop in the company's

stock price during the period from 2005 through 2007, as

measured by a net-of-market one-day price decline of 20% or

more.2 We find that the probability of a filing over

the three months following such price drops increases with the

size of the drop.

Even as filings were increasing in 2007 and 2008, average

settlement values remained around $30 million. Removing

settlements over $1 billion from the calculation, the 2008

average settlement actually fell to $10 million, well below the

level of recent prior years, and much closer to the 2008 median

of $6 million.

Although it is too early to know whether recently filed

cases will result in big settlements, there is reason to expect

that they will. Investor losses—a powerful determinant of

settlement size—for cases filed in the first six months

of 2008 have a median value in excess of $800 million,

substantially higher than the approximately $350 million median

for cases settled in the 2005-2007 time frame. The sharply

higher investor losses of recent cases are largely a subprime

phenomenon: median investor losses so far this year are more

than 10 times as large in subprime cases as in non-subprime

cases.

Filings

Recent Trends

After dipping sharply to a more than 10-year low of 131

filings in 2006, federal shareholder class action filings began

to increase in 2007. By year-end, there were a total of 195

filings, surpassing the 2005 level. Through June 30, there have

already been 139 filings in 2008. If activity continues at this

pace, there will be almost 280 filings in 2008, the highest

level since 2002.

Six-month data reveals more about the timing of the collapse

and subsequent upsurge in filings. Filings fell precipitously

in the second half of 2005, but this drop is masked in the

annual data by the relatively high filings in the first half of

that year.

Filings grew most strongly in the second half of 2007. This

increase coincided with the first subprime-related filings:

there were only nine subprime filings in the first half of

2007, but more than three times as many in the second

half.3 The first half of 2008 brought another 49

subprimerelated shareholder class action filings, plus 22 other

cases related to auction-rate securities market

failures.4 Although the majority of options

backdating cases were filed in 2006, a handful of these

contributed to the 2007 and 2008 upswing.

Figure 1. Federal Filings

January 1, 1996 - June 30, 2008

Figure 2. Federal Filings: Six-Month Intervals

January 1, 2002 - June 30, 2008

Figure 3. Federal Filings by Circuit, Year, and Type

of Case

January 1, 2006 - June 30, 2008

Figure 4. Federal Subprime and Auction-Rate

Securities Filings by Circuit

January 1, 2007 - June 30, 2008

Notably, subprime and auction-rate securities cases alone

cannot explain the increase in filings. Since June 2007,

standard filings—which exclude auction-rate securities,

subprime-related, and options backdating cases—have

exceeded the levels of 2006 and the first half of 2007.

Historically, securities class action filings have been

concentrated in the Second Circuit (including Connecticut, New

York, and Vermont) and the Ninth Circuit (which includes

California and certain other Western states and territories).

This remains the case in 2008. Year-to-date, the Second Circuit

has seen more than twice as many filings as the Ninth, due in

large part to subprime and auctionrate cases; the financial

institutions that these cases target are concentrated in New

York. For standard filings, on the other hand, the Second

Circuit is ahead of the Ninth by only 30%.

The concentration of issuers in the Second Circuit is

particularly great in auction-rate securities cases, which

first appeared in 2008. While seven of these cases are to be

found among the Seventh, the Eighth, the Ninth, and the 11th

Circuits, the other 15 are all in the Second.

While subprime and credit crisis-related filings are

primarily a Second and Ninth Circuit phenomenon, all Circuits

have had at least one such case. In 2007, seven subprime

filings were filed in the 11th Circuit—which includes

Florida, a state associated with some of the earliest

subprime-related disclosures—but the 11th Circuit has had

...

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